Spanish debt wilts amid €250bn rescue plan confusion

Thursday, June 17, 2010

By Paul Martin

European debt markets remain under high stress on persistent reports that Spain is in secret talks with EU officials and the International Monetary Fund for a support package of up to €250bn (£208bn), the largest rescue in history.

The spreads on 10-year Spanish bonds jumped to a post-EMU high of 224 basis points above German Bunds as traders brace for a crucial auction by Madrid on Thursday. The relentless rise in bond yields replicates the pattern seen in Greece at the onset of crisis. Spain must raise €25bn of debt in a cluster of auctions in July.

“We’re in a dangerous and stressful situation,” said Gary Jenkins, a credit expert at Evolution Securities. “Spain is a big enough borrower to wipe out the EU’s rescue fund.”

Elena Salgado, Spain’s finance minister, reacted angrily to a report in the Spanish daily El Economista claiming that the support plans are well advanced.

“It has been denied by the Spanish government, by the European Commission, and by the IMF. How much more can we deny it?” she said.

The story refuses to die, however. Three German newspapers have run similar stories over recent days, citing German sources. The markets are convinced that some form of contingency planning is underway.

“In our view there is absolutely no doubt that a backstop facility for Spain will be put in place should stress in the system remain,” said Silvio Peruzzo, an economist at RBS,

El Economista said officials from the EU, the IMF, and the US Treasury had been discussing a credit line of €200bn to €250bn, dwarfing the €110bn package for Greece. Dominique Strauss-Kahn, the IMF’s managing director, reportedly called a secret meeting of the IMF’s Board of Directors to tackle the crisis.

The loan terms would be softer than the draconian budget cuts imposed on Greece, with the lion’s share of the money coming from eurozone states under their €750bn shield.

Mr Peruzzo said the facility was likely to resemble the IMF’s Flexible Credit Line devised for Poland and Mexico. This is a “precautionary” credit for healthy borrowers facing a “cash crunch”. The funds can be drawn at any time, without strings attached.

Mr Jenkins said it is unclear how the EU would finance a full rescue for Spain. Under the Greek formula, the EU-IMF ratio of aid is 8:3, implying an EU share of around €180bn – with a risk that the sums will escalate. The number of eurozone states available to fund the package is shrinking.

“The issue here is political risk. If they keep bailing out countries, it will mean printing money: that is not going to go down well in Germany,” he said.

Theodora Zemek from AXA Investment Managers said any rescue will have knock-on effects on the credit ratings of donor states. “Germany and France risk going from AAA to AA,” she said.

The original hope behind the EU’s €750bn “shock and awe” headline was that the announcement of such sums would end all doubts about the political solidarity behind the euro project, but nationalist body-language from EU capitals and daily spats between France and Germany have sapped confidence.

What haunts markets is fear that Spain may be the last line of defence. There can be no easy rescues after that because the money will run out. If investors ever start to question Italy’s public debt – the world’s third largest – they may face a sovereign version of the Credit Anstalt crisis of 1931. So far, Italy has remained as strong as a rock.